Testing Uncovered Interest Rate Parity and Term Structure Using a Three‐regime Threshold Unit Root VECM: An Application to the Swiss ‘Isle’ of Interest Rates*

In this article, a three‐regime multivariate threshold vector error correction model with a ‘band of inaction’ is formulated to examine uncovered interest rate parity (UIRP) and expectation hypothesis of the term structure (EHTS) of interest rates for Switzerland. Combining both UIRP and EHTS in a model that allows for nonlinearities, we investigate whether the Swiss advantage is disappearing with respect to Europe. Our results favour threshold cointegration and show that both hypotheses hold, at least in one of the three regimes of the process for Switzerland/Germany. The same is not true between Switzerland and the United States.